Is the boom over for alternative energy – or just getting started?

March 21, 2008

Everyone it seems has been investing in green energy – from Google to ExxonMobil. But this year the booming sector is suddenly in a serious funk. So is this time to get out – or jump in and snap up some long-term winners? To find out, the Monitor's Laurent Belsie recently talked with three experts who closely follow the field: Matt Patsky, portfolio manager of the Winslow Green Growth Fund, Paul Hilton, director of advanced equity research at Calvert, and Eric Becker, portfolio manager with Trillium Asset Management. Here are edited excerpts of their conversation:

Matt, you've had the No. 1 fund of all small-cap growth funds over the past five years. This year the sector has tanked. What happened?

Patsky: It obviously has been a very difficult market overall in the beginning of 2008. In addition, our focus, particularly in our Winslow Green Growth Fund, is small-cap growth. And small-cap growth has been particularly under pressure..... You've seen stocks that run [up] the most come down the hardest, even if everything's fine in terms of fundamentals.

Hilton: I don't think so. If you look at the long-term trends that are supporting alternative energy, there's no doubt that this really is a good play.... There will be short-term volatility. But if you look at things like the price of oil, the amount of new investing that's going into promoting new companies in this space, all the potential climate-change legislation that we're seeing, this really does create a perfect long-term [opportunity] for this sector.

How important is the price of oil going forward?

Becker: I think the price of oil is important mainly for psychological reasons, because most of the alternative-energy companies we focus on are producing electricity. And electricity is not produced from oil for the most part. It's from natural gas and coal. But those prices have also jumped significantly. The price of electricity has pretty much followed the price of natural gas and oil. In the past six months or so, it's practically doubled – the wholesale price of electricity in some regions. And so that makes for an environment that's very good for solar and wind companies [and] others that are producing electricity from alternative sources.

So if oil prices stay high, it's full speed ahead for green energy?

Patsky: There's a couple of factors. One is prices. And that's certainly a major factor globally. But you also have to remember that there's now renewed concern about energy security, which has changed the debate in this country to being one of bipartisan support for developing reliable energy supplies domestically. And that has to include renewables. So I think there is tremendous growth ahead over the next decade for renewable energy.

But what happens if alternative-energy tax credits expire at the end of this year as they're slated to?

Hilton: We certainly are concerned about the tax-credit issue. And, in fact, many of the new projects that would be coming on line, if they're not done by March, will not be able to qualify for the tax credit if it doesn't go through.... In effect, what's happening is the Republicans don't see any real incentive in getting it through, and the Democrats on the other side would love to be able to point to the fact that there's a failure. So when it comes to election time, they can come back and say: "Hey, look, we tried to get this through and it was blocked."

So prospects are bad for passage.

Becker: Prospects are poor in the very short term. But if you take one step back and look at the three main contenders for the presidency right now, all three support climate-change legislation and, I think, policies that are going to be supportive of renewable energy..... In the next administration, you're going to see ... some climate-change legislation and strong support for renewable-energy technologies.

But wouldn't a gap in tax credits hurt the companies you're investing in?

Hilton: One thing to think about is that it's not just about the US. If you look at where a lot of the growth is coming [from], it's coming from Europe – it's coming from Spain, it's coming from Germany. Just as likely, it's coming from China, where you see that they've already made a 15 percent commitment to renewable energy for a long-term energy goal. So the US is part of the story, but it's not the full story for many of the companies in our fund.

Are prospects better for wind or solar or some other alternative fuel?

Hilton: The best companies we think are in the wind and solar area. If you look at wind, it's the most competitive option right now in terms of relative price. Many of the wind companies have held up quite well, even with this most recent downturn. Companies like Vestas and Gamesa have done quite well, because if you look at it, they're still able to sell, even when there are some concerns about what's happening with the market. Same thing with solar. Where we're a little less excited is areas like biofuels and also geothermal.

Why are they less exciting?

Hilton: The reality is you're just not seeing quite the same growth prospects that you're seeing for wind and solar. I think revenue growth in the wind and solar space is probably going to be about 20 percent a year for the next five years because it's cost competitive.

Becker: Keep in mind the base that these things are working off right now globally – 0.01 percent of electricity is generated from solar power. That is going to ramp up dramatically. Wind is about 1 percent of global electricity generation. It's already about 100 times larger than solar, so solar has a huge potential for growth. That means that there's more competition, too. You've seen a tremendous explosion of capacity coming on line for solar-cell production and solar-module production in China. And so it's becoming commoditized in some sense – solar panels – which makes for more difficulty in picking winners within the solar field.

Patsky: I would say the biggest opportunity we see – and probably the lowest-hanging fruit – is energy conservation. So that's where we're seeing the best opportunities.

How do you invest in conservation?

Patsky: It's basically a resource-efficiency play. You've got rising costs of resources. Now we need to look at who can help in reducing the amount of resources that need to be used to make the same product or light the same room or heat the same building..

What companies look particularly interesting?

Hilton: One of the companies that we like ... is a company called D1 Oils. And it is in the biofuels [field], but it's not really focusing on corn ethanol and some of those areas that have had a lot of concerns. Instead, D1 Oils focuses on a plant called jatropha. What's interesting about jatropha is that you can actually plant it in nonarable areas – in Africa and in India. So it doesn't directly compete with croplands. But they still believe that this is going to be a viable option in order to create biodiesel.

Becker: I would say it would be a mistake to choose just one company to invest in in this area, because the technological change – the amount of money pouring into research and development right now – is so great that the prospects for one particular company's technology being leapfrogged makes it dangerous to put all your eggs in one basket. So I would say, focus on a mutual fund or an exchange-traded fund. There's a global clean-energy ETF that we like for quick diversification in the space.

Patsky: Our largest holding is Vestas and that's certainly a name I would feel comfortable putting my mother in. It's the established leader in wind turbines. And that is a market that I think has great prospects over the next two to five years.

You ask us to be patient with green-energy investments. How patient?

Hilton: I think five or 10 years to really see a big turnaround in where things are going.